BANK OF CHINA (HONG KONG) LTD. v. GUANGDONG WATER CONSERVANCY & HYDRO-POWER ENGINEERING DEVELOPMENT CO. LTD.

HCMP 407 of 2002

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO. 407 OF 2002

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REASONS FOR DECISION

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1. On 21 March 2002, there were three matters before me:-

(1) a summons filed on 30 January 2002 issued by Bank of China (Hong Kong) Ltd ("the Bank") by which the Bank sought the continuation of an ex parte interim order granted by Chu J on 30 January 2002 staying the liquidation of Guangdong Water Conservancy & Hydro-power Engineering Co Ltd ("the Company") commenced under the special procedure in s.228A Companies Ordinance;

(2) a summons filed on 26 February 2002 issued on behalf of the Company for the discharge of the ex parte order on the ground that there had been material non-disclosure; and

(3) directions for the hearing of the Originating Summons in these proceedings for an order that the s.228A liquidation be stayed permanently.

2. At the end of the hearing, I made an order discharging the ex parte order and directed that there be an enquiry as to any damages that may have been caused by the order for which the Bank had given an undertaking to pay.

3. However, I also made a fresh order that the s.228A liquidation should be stayed in the interim pending the determination of the Originating Summons, and I gave directions for that hearing.

4. I indicated at the end of the hearing that I would reduce the reasons for my decision into writing which Reasons for Decision would be handed down. I do so now.

Background

5. The applications arose against the background of the following facts. Towards the end of last year, the Company entered into discussions with the Bank (together with other bank creditors) regarding proposals for debt restructuring.

The KPMG Analysis

6. KPMG Financial Advisory Services Ltd were retained as independent financial advisors in respect of the debt restructuring proposal. An appraisal and liquidation analysis was prepared which in its draft form was made available to the bank creditors in mid-December 2001. On 3 December 2001 a petition had been presented for the winding-up of the Company by a creditor called Top Treasure Engineering Co Ltd.

7. The KPMG analysis showed that the total liabilities of the Company and its subsidiaries exceeded total assets by $423m, implying a net liabilities position of $422m. The Company through its wholly owned subsidiaries had borrowed substantial amounts of money to acquire properties which had significantly devalued. In the section on Background and Current Position, KPMG reported that "the majority of the Group's debt relates to investment in property assets that have depreciated in value substantially over the past few years".

8. In its calculation of net liabilities, KPMG did not include the Company's potential liability to Government for liquidated damages for delay in the completion of three construction contracts. Work had stopped on two of the contracts and was continuing at a slower rate for the 3rd contract. KPMG reported that if these construction contracts were determined and Government re-entered, liquidated damages would be payable. The costs arising from the determination of the contracts were estimated by expert assessors at $500m.

9. It would thus have been clear to the bank creditors that the Company's potential liability to Government arising from the construction contracts would be on top of the already substantial net liabilities position.

Section 228A liquidation

10. Subsequent to the KPMG analysis, there were further negotiations between the Company and the bank creditors. Meanwhile, at the end of December 2001, Government re-entered two of the three sites.

11. On 2 January 2002, the negotiations between the bank creditors and the Company's controlling shareholder broke down. On 3 January 2002, the directors of the Company commenced the winding-up of the Company under s.228A Companies Ordinance.

12. Section 228A is a special procedure for liquidation when directors of a company have formed the opinion that the company cannot by reason of its liabilities continue its business, and they consider it necessary that the company be wound up and it was not reasonably practicable for the winding-up to be commenced under another section of the Companies Ordinance. It is a unique type of voluntary winding-up, which is not to be confused with members voluntary winding-up or creditors' voluntary winding-up (see s.233(4) CO).

13. In the minutes of the board meeting, the directors stated that they had reviewed the impact of the declining property market after the Asian financial crisis and referred to the situation on-site at the three construction sites.

14. When the s.228A procedure is invoked, the directors are required to forthwith appoint provisional liquidators who must be either solicitors or accountants. Mr G. Tam and Mr J. Muk of KPMG were accordingly appointed Joint and Several Provisional Liquidators.

15. Under the s.228A procedure, meetings of the shareholders and the creditors have to be summoned within 28 days of the delivery of a statutory declaration under s.228A(1). The meetings were duly summoned for the afternoon of 30 January 2002.

Bank creditors discovery

16. Notwithstanding the commencement of the s.228A winding-up, the bank creditors continued with their attempts to avoid the liquidation of the Company.

17. At a meeting of the bank creditors on 22 January 2002, a sub-contractor noted that the incorporation date of the Company was subsequent to the date of five "C" grade government construction licences in the name of the Company. Apparently, the licences were granted to a company incorporated in the PRC by the same name and with the same company chop.

18. This led the bank creditors to think that the Company might not be liable to the Government under the three construction contracts as it was believed that Government would only award construction contracts to licence-holders.

19. The bank creditors however did not make any inquiries on this issue from the Provisional Liquidators or the directors of the Company for a week.

20. On 29 January 2002, a day before the meetings were to be held, the Bank's solicitors wrote to the Provisional Liquidators saying that "there may be a genuine mistake", and that there was an issue whether the information in the KPMG analysis was correct, and whether the Company was "solvent, insolvent, can be rescued or not". The Bank called for a consensual application to stay the winding-up.

21. The Provisional Liquidators' solicitors replied on the same day saying that it could not be inferred from the holding of the licences that the Government's construction contracts were made with the PRC entity. The relevant contractual documentation, the party to whom payments were made and the practice of the Company and its counterparties over the years pointed to the Company being the contracting party (and accordingly, liable under the Government construction contracts).

22. The Provisional Liquidators' solicitors also pointed out that uncertainty in this respect did not mean that the Company was likely to be solvent. On the contrary, it put the assets side of the Company into doubt and made it more likely, rather than less, that the Company was insolvent.

23. Although no express references were given in that reply, that was a logical deduction as the KPMG analysis had reported a substantial deficit even without having included any liabilities under the Government construction contracts.

Application for ex parte interim stay

24. Notwithstanding this, the Bank made an ex parte application before Chu J. the next day, on the morning of the meetings scheduled under s.228A, for an interim stay of the s.228A liquidation. The application was made on notice to the Provisional Liquidators, who attended by their solicitor.

25. At paragraph 9 of the affirmation in support of the ex parte order, the Bank's Assistant General Manager said that "it is totally unclear to the bank creditors if the [Company] is solvent or insolvent and even if it is insolvent, given that a large part of the liability to the Government is possibly owing by the Chinese entity, whether there is the opportunity to rescue the [Company]".

26. Although the KPMG analysis was exhibited, the only reference to it in the affirmation was that it "seems to assume that the [Company] was the contractor of the Government". Nothing was said about the fact that KPMG had reported that the net liabilities position was mainly due to the devaluation of the properties, nor the fact that the substantial liabilities position had not included the potential liabilities to the Government. Indeed even if the entire sum for existing trade payables were deducted from the liabilities figure, there would still have been a substantial net liabilities figure.

27. At the hearing before Chu J, the primary submission made on behalf of the Bank was that it had issued proceedings for a stay of the s.228A liquidation "on the grounds that the power under s.228A has been misused as a result of this mistake (referring to the licences)". In answer to the Judge's question whether the effect of the mistake was an "all-determining factor" in considering whether s.228A had been properly used, it was submitted that

"the relevance of the mistake, for the purpose of this morning, is that the [Company] mistakenly believe that they were the licensees of the five licences and therefore that they were the contractual party in respect of the three ... construction projects in Hong Kong. And therefore, as a result of the problem with the project, they became liable to the government. ...

So they became liable and they had financial problems arising out of the three projects. As a result of the financial problems they considered that they couldn't carry on the business and therefore they resorted to section 228A. If the truth is that in fact the contract with the government was a PRC entity, not the Hong Kong Company, then all those liabilities would be the liabilities of the PRC company, not the [Company]. In which case the [Company] may well be a solvent company and there would be no basis for any liquidation, let alone liquidation under s.228A".

Non-disclosure of Company's financial position excluding potential liabilities to Government

28. Although the Judge also raised the issue whether s.228A should have been invoked instead of s.228, it is clear from the transcript that the ex parte application was mounted and advanced by the Bank on the basis that the Company might well be a solvent company "with no basis for any liquidation, let alone liquidation under s.228A", without referring the Judge to the Company's financial position if the potential liabilities to Government are excluded. That position was well-known to the Bank from the KPMG analysis which was in the 120-page bundle put before the Judge.

29. It is well-established law that facts are material and should be disclosed if they are "relevant to the weighing operation" which the court has to make in deciding whether or not to grant the ex parte order (Thermax v Schott Industrial Glass [1981] FSR 289, 298). The practice of the courts when material non-disclosure has attended the obtaining of the ex parte injunction is to discharge the order without going into the merits, although the court may in its discretion grant a fresh order.

30. In the present case, the issue of the Company's possible solvency if there were no liabilities to Government was relevant to the weighing operation. In the brief reasons she gave for her decision granting the interim stay, the Judge said that it was arguable whether it was not practicable to use other statutory provisions for winding-up, such as s.228. She then said "there is additionally the point with regard to whether the Company is in fact solvent or otherwise. This arises out of the question of the holder of the government licences". Clearly therefore, the Judge was led to think that the Company's solvency depended upon its liability to Government under the construction contracts, in ignorance of the Company's position.

31. It is well-established law, and it is not disputed by the Bank, that the test of materiality is objective, and its motive was irrelevant. It is also accepted that it is irrelevant that the Judge would have made the same decision even if there had been proper disclosure. Given the way the application was made (as set out in paragraph 27 above) emphasizing the possibility that the Company might be solvent, it was necessary that the Judge was informed of the rest of the Company's liabilities in the KPMG analysis. It matters not whether a court could have ruled finally whether the Company was solvent or insolvent. The duty incumbent on the ex parte applicant was to fully and frankly refer the Judge to the materials available to it then.

32. In the circumstances, I discharged the ex parte interim order. As a matter of completeness, I would record that the Company had also relied on three further matters that it said the Bank had failed to disclose. The first was as to Top Treasure's position vis-a-vis the petition. The Judge was informed that Top Treasure had agreed to withdraw the petition. There is now correspondence from Top Treasure's solicitors to the effect that they had only informed the Bank's solicitors that they would agree to adjourn the hearing of the petition, not to withdraw it altogether. In the absence of full evidence from the two solicitors who discussed the matter apparently on the telephone, the materials are too uncertain at this stage for the Court to base any decision upon them.

33. Another matter was that the Bank should have known that the Company was the true contracting party because two of the supporting banks (the Chiyu Bank and Citic Ka Wah Bank) had copies of the contracts in question which showed the Company as the contracting party. I accept however that the Judge was referred to the correspondence from the Provisional Liquidators' solicitors which stated that the contractual documentation showed that the contracting party was the Company.

34. Finally there was the assertion on the part of the Bank that it and the supporting bank creditors formed the majority of the Company's creditors. The Company says that if only the unsecured creditors were unconsidered, the bank creditors would not form the majority of creditors. In this respect, it would appear that the Bank only asserted that it and the other bank creditors formed the "majority of creditors" without differentiating between secured and unsecured creditors, so that there was no misrepresentation of the position.

Order

35. Accordingly, I ordered that the ex parte order be discharged, with an inquiry as to the damages that may have been suffered as a result of the order.

36. However in light of the fact that the winding-up petition has since progressed and provisional liquidators have been appointed by the Court, no purpose would be served by the continuation of the s.228A liquidation now and I therefore ordered that there should be an interim stay pending determination of the Originating Summons.